Posted on: May 18th, 2023
Acquisition loans are an important part of the middle market lending ecosystem. They provide a reliable way for companies to scale up through providing an accommodative loan structure conducive for strategic growth. Despite their standing in the upper echelon of corporate finance tools, most companies regard acquisition loans in a low value, utilitarian way as dollars at a price. They are seen as a one-off way to fund the acquisition purchase price. This myopic view causes acquiring companies to underappreciate the role acquisition loans play as a delivery vehicle of the strategic growth plan.
Acquisition loans are best conceived when they reflect the totality of the strategic growth plan including acquisition frequency, acquisition quality and holistic capital needs. It makes little sense for a company focused on multiple acquisitions to take an acquisition loan that cannot be upsized to fund follow on deals. Yet many companies do this very thing when they adopt this one-off siloed approach and pursue an SBA loan. The best form of an acquisition loan for a roll-up transaction is one with an initial funding supplemented by an accordion facility that can be used as an acquisition facility for future deal flow. The acquisition loan selection must also factor in the complexity and the quality of the acquisition. Plain vanilla, high quality deals can be financed all day long with senior bank debt.
However, storied deals with operational issues invariably pose significant challenges to integration and to resource availability. Sometimes the deal involves so much change management and reorientation that the performance of the acquiring company can take a hit. Tougher deals require a lender who is smarter, more patient and more risk tolerant such as a mezzanine debt lender or a unitranche provider. The acquisition loan must consider future working capital and growth capital needs for the business and bake that into the debt structure. As companies acquire and grow, their working capital and cash flow usually gets inadvertently reinvested in the acquisition integration resulting in tighter liquidity. Companies should ensure that a portion of the acquisition loan is allocated to working capital and growth capital needs so as not to borrow from Peter to pay Paul.